Many investors tend to get fixated on the price-to-earnings (P/E) strategy while seeking stocks that are trading at attractive prices. Without doubt, P/E is the most popular multiple used by investors for working out the fair market value of a stock. But even this widely used valuation metric is not devoid of limitations.

Why EV/EBITDA is a Better Approach?

While P/E is the most popular valuation metric, a more complicated multiple called EV/EBITDA works even better. Often considered a better alternative to P/E, it gives the true picture of a company’s valuation and its earning potential and has a more complete approach to valuation. While P/E just considers a firm’s equity portion, EV/EBITDA determines its total value.

Also known as the enterprise multiple, EV/EBITDA is essentially the enterprise value (EV) of a stock divided by its earnings before interest, taxes, depreciation and amortization (EBITDA). The first constituent of the ratio, EV, is a firm’s market capitalization plus the market value of its debt and preferred equity minus cash.

The other constituent, EBITDA, gives a clearer picture of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that depress net earnings. It is also often used as a proxy for cash flows.

Typically, the lower the EV/EBITDA ratio, the more appealing it is. A low EV/EBITDA ratio could signal that a stock is undervalued.

Unlike the P/E ratio, EV/EBITDA takes debt on a company’s balance sheet into account. Due to this reason, it is typically used to value potential acquisition targets. The ratio shows the amount of debt that the acquirer has to bear. Stocks flaunting a low EV/EBITDA multiple could be seen as attractive takeover candidates.

Another key downside of P/E is that it can’t be used to value a loss-making entity. Moreover, a company’s earnings are also subject to accounting estimates and management manipulation. In contrast, EV/EBITDA is harder to manipulate and can also be used to value companies that have negative net earnings but are positive on the EBITDA front.

EV/EBITDA is also a useful tool in measuring the value of companies that are highly leveraged and have a high degree of depreciation. It also allows the comparison of companies with different debt levels.

However, EV/EBITDA is also not without its shortcomings and it alone can’t conclusively determine a stock’s inherent potential and its future performance. The multiple varies across industries (a high-growth industry typically has higher multiple) and is generally not appropriate for comparing stocks in different industries due to their diverse capital requirements.

Thus, instead of solely banking on EV/EBITDA, you can club it with other key ratios in your stock investment toolkit such as price-to-book (P/B), P/E and price-to-sales (P/S) to uncover bargain stocks.

Screening Criteria

Here are the parameters to screen for value stocks:

EV/EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV/EBITDA ratio represents a cheaper valuation.

P/E using (F1) less than X-Industry Median: This metric screens stocks that are trading at a discount to their peers.

P/B less than X-Industry Median: A lower P/B compared with the industry average implies that the stock is undervalued.

P/S less than X-Industry Median: The lower the P/S ratio the more attractive the stock is as investors will have to pay a smaller price for the same amount of sales generated by the company.

Estimated One-Year EPS Growth F(1)/F(0) greater than or equal to X-Industry Median: This parameter will help in screening stocks that have growth rates higher than the industry median. This is a meaningful indicator as decent earnings growth always adds to investor optimism.

Average 20-day Volume greater than or equal to 100,000: The addition of this metric ensures that shares can be traded easily.

Current Price greater than or equal to $5: This parameter will help in screening stocks that are trading at a minimum price of $5 or higher.

Zacks Rank less than or equal to 2: No screening is complete without the Zacks Rank, which has proven its worth since inception. It is a fundamental truth that stocks with a Zacks Rank #1 (Strong Buy) or #2 (Buy) have always managed to beat adversities and outperform the market.

Value Score of less than or equal to B: Our research shows that stocks with a Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential.

Here are five of the nine stocks that passed the screen:

Amkor Technology, Inc. (AMKR Quick QuoteAMKR - Free Report) is a leading provider of semiconductor packaging and test services. Moreover, the company is one of the leading developers of advanced semiconductor packaging and test technology. This Zacks Rank #1 stock has expected year-over-year earnings growth of 29.4% for 2016 and 40.9% for 2017.

Semiconductor Manufacturing International Corp. (SMI Quick QuoteSMI - Free Report) is one of the leading semiconductor foundries in the world and the largest and most-advanced foundry in Mainland China. This Zacks Rank #2 company delivered an average positive earnings surprise of around 53.9% over the trailing four quarters.

Principal Financial Group Inc. (PFG Quick QuotePFG - Free Report) is a leading provider of retirement savings, investment and insurance products and services. The company carries a Zacks Rank #2 and has an expected EPS growth rate of 6.4% for 3 to 5 years. You can see the complete list of today’s Zacks #1 Rank stocks here.

Insight Enterprises Inc. (NSIT Quick QuoteNSIT - Free Report) is a global direct marketer of brand name computers, hardware and software. The company markets to small-and-medium-sized businesses, through a combination of a strong outbound telemarketing sales force, electronic commerce, electronic marketing and direct mail catalogs. This Zacks Rank #2 stock has expected year-over-year earnings growth of 14.9% for 2016.

Comfort Systems USA Inc. (FIX Quick QuoteFIX - Free Report) is a national provider of comprehensive heating, ventilation and air conditioning installation, maintenance, repair and replacement services. This Zacks Rank #2 company delivered an average positive earnings surprise of around 28.2% over the trailing four quarters.

You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.

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